Canada

In 2007, the Canadian economy essentially averted the slowdown developing in the United States. Wage and job growth provided solid support for household consumption. Both residential and non-residential construction continued to trend up, representing 25 per cent of GDP growth. The Canadian dollar appreciation undercut, however, the increase in export revenues associated with the soaring prices for raw materials—oil, coking coal, electricity, grain and metals—and also undermined the prices and the volumes of traditional exports to the United States, which absorbs the highest proportion of them by far.

The economy should remain relatively firm in 2008. Consumption will benefit again from a bright job picture, especially in the public sector, and from further reductions of direct and indirect taxes facilitated by the public sector financial surplus and continued debt reduction. Taking advantage of new, generally more favorable amortization rules, companies will increase their investments in commercial and office premises. Public institutions will maintain a high level of spending on infrastructure, health and education. A tightening of credit will undermine residential construction (40 percent of building and public works activity). Export volumes have been contending with the weaker demand for construction in the United States.

Corporate financial health is still generally good as evidenced by the good Coface payment incident index for Canada and the continued decline of bankruptcies. Beyond this general economic assessment differences emerge between regions and sectors. A dichotomy will notably persist between the Western provinces underpinned by raw materials and the Central provinces (Quebec, Ontario) very dependent on a manufacturing industry suffering from both unfavorable exchange rates and competition from emerging countries. While the aviation industry and facilities for energy production, mine operation, construction and agriculture have outperformed, other sectors have fared less well. Car industry parts manufacturers, who do 90 percent of their business with the three major North American carmakers, have suffered from the decline in local production and the reduction in the number of Canadian parts contained in vehicles. Tourism has suffered from the decline in the number of visitors from the United States. Retailers located near the southern border have felt the effects of cross-border purchasing by Canadians. The wood industry has been contending with the weaker demand for construction in the United States.

China

Economic growth accelerated again in 2007 (up by 11.5 percent) spurred by strong investment. Officials have been concerned about the overcapacity in the car, steel and construction industries, which could lead to tighter margins and financial difficulties, a risk already evidenced by a lengthening of payment times recorded by Coface. In view of the priority given to avoiding a catastrophic hard-landing scenario, monetary policy will remain strict, the moderate yuan appreciation will speed up slightly, and further administrative measures intended to cool off the economy appear likely. A gradual slowdown is therefore the most probable scenario. But even then, credit risk on companies continues to grow with the overcapacity suggesting that a shakeout will be unavoidable. Inflation accelerated in 2007 due mainly to rising food prices. The remedial measures taken—eight increases in mandatory bank reserves and five interest rate hikes—had only a limited impact last year. Monetary policy will thus tighten further in 2008.

Financially, despite the appreciable total amount of extra-budgetary commitments, sovereign risk has remained limited. Moreover, China’s external position is still very solid, with foreign exchange reserves at record levels. The surplus liquidity generated by the large current account surplus and the massive influx of capitals end up in the stock market, with the Shanghai stock market index more than doubling in 2007. The very high price earning ratios prevalent in China compared to those in other Asian stock markets are indicative of an emerging speculative bubble. Volatility risk has thus been very high.

Politically, China remains stable with Hu Jintao re-elected as general secretary of the Chinese Communist Party. However, social tensions and inequalities between urban and rural areas represent serious risks. Nonetheless, in the short term, the government is likely to hold them in check. Governance moreover still presents major deficiencies. Recent measures to combat corruption have yet to contribute to a significant improvement in the business climate.

Mexico

Even with the economy still mainly driven by domestic demand, growth should remain moderate in 2008 due notably to the economic slowdown in the United States on which Mexico continues to depend as an outlet for its exports. Inflationary pressures, mainly attributable to the increase in food and energy prices, should remain under control, thanks to a tightening of monetary policy.

The international financial turmoil should have limited impact on a relatively diversified economy with reasonably solid foundations. Public finances should continue to improve, even if they remain dependent on oil revenues, with already moderate external debt ratios easing further. Amid a decline in oil production, less dynamic exports to the United States and a slowdown of emigrant worker remittances, the external account deficit will widen. Foreign direct investment should nonetheless cover half of Mexico’s financing needs, with short-term debt remaining moderate.

Stronger growth—especially desirable in view of demographic growth—would nonetheless require increased investment and modernization of the entire economy. State-run energy companies have performed poorly. The level of skills in the labor force will have to rise in order to move production up-market. Reforms have come up against stiff social and political resistance, however, with President Calderon’s National Action Party (PAN) conservative party lacking a parliamentary majority. The adoption of partial pension and tax reforms at the president’s initiative in 2007 was nonetheless an encouraging step forward.

In that context, the Coface payment experience has remained satisfactory. Sectors linked to construction, retailing and, to a lesser degree, the car industry have been the most dynamic. The few rough patches encountered in the dairy industry and textiles are the result of particular problems or difficulties experienced in meeting foreign competition.

Japan

A slight rebound in household consumption notwithstanding, economic growth slowed in 2007 as did exports and corporate investment. The stiffening of anti-seismic standards severely disrupted the residential construction sector, delaying delivery of building and works permits.

The economy will weaken further in 2008. The yen appreciation in conjunction with a more pronounced North American economic slowdown will continue to hamper, nonetheless, strong export growth. Companies will have difficulty remaining price competitive with the rising prices of energy and certain raw materials squeezing their margins. In this context, they will remain vigilant on investment policy and hiring. Despite the shortage of skilled labor, wages should thus register only moderate increases; which will limit the growth of consumption (56 percent of GDP). Problems linked to property investment will only be reabsorbed gradually. Households will cut back on spending as they contend with surging prices for energy and food products. Despite upward pressure on imported goods, consumer prices should only increase slightly with the risk of deflation continuing to overhang the Japanese economy. The fiscal deficit and public debt will remain at record levels with tax revenues likely to be flat amid the economic slowdown. Measures essential to improvement in public sector finances, including increases in VAT on consumption will likely be postponed again pending the next parliamentary elections in 2009.

Japanese companies are generally in good financial health with a high rate of profit (about 11 percent of GDP), high cash flow, and recourse to borrowing in steady decline as they continue to reduce nonetheless, still high debt (95 percent of GDP). Reflecting that favorable situation, the Coface payment incident index has been below the world average. Companies should thus, not suffer from a credit crunch. These statistical data, particularly applicable to large manufacturing companies, tend to mask the reality faced by smaller companies, which have been experiencing increasing difficulties particularly when located outside major metropolitan areas and operating exclusively in the domestic market. Bankruptcies, after declining the past four years have begun to increase again. Operators in a range of sectors will thus bear particularly close watching: construction, property, wholesaling, hotel-catering and consumer electronics.

Germany

Exports and productive investment were the main economic engines again in 2007, with exports holding up well in the face of the euro appreciation against the dollar. They comprise mostly capital goods, high-end cars and chemical and pharmaceutical products relatively insensitive to price variations. Moreover, 60 percent go to the EU with a good proportion of the balance representing sales to emerging countries in Asia and Central and Eastern Europe where demand has remained strong. Expiry of advantageous amortization rules late last year spurred productive investment. Household consumption and residential construction suffered conversely from the increase in VAT.

A slowdown is expected in 2008 with a smaller positive contribution from foreign trade not offset by the recovery of private consumption. The growth of exports will be slower due to the still unfavorable exchange-rate effect on price-competitiveness and to the economic slowdowns in Europe and the United States. Import growth will remain strong meanwhile reflecting the revival of household demand, buoyed by the continuing decline of unemployment and the concomitant decline in the unemployment-insurance contribution rate as well as by increases in civil service wages, pensions and aid for the education of children. The revival of private consumption will nonetheless be modest due to the unfavorable effect of the rising cost of credit as well as of energy and food. Faced with weaker foreign demand, industry will slow the pace of its investments.

Corporate payment behavior has remained good as evidenced by the excellent level of the Coface payment incident index for Germany and the 8 percent decline in bankruptcies in the first nine months of 2007. The reduction of corporate income tax this year in a context of balanced public finances will have a positive influence on that trend. The residential construction sector will remain mired in difficulty, however, particularly in the eastern regions. The kitchen furniture sector also presents a high-risk profile at this juncture. The automotive subcontracting sector, meanwhile, has suffered from the increasing pace of relocations to the eastern part of the continent.

UK

Despite a slowdown in the fourth quarter, economic growth remained strong in 2007. Households increased their spending encouraged by strong job creation notably in services (three-quarters of GDP) and construction. Public spending remained dynamic with much ground to make up as regards public health, education and infrastructure, which has contributed to a continuing large public sector deficit.

The British economy will be markedly less dynamic this year due mainly to sharp slowdown of both household consumption and investment. Households will be faced with a slower pace of job creation in the public and financial spheres, which will not, however, result in increased unemployment, due to easing immigration. The slow growth of disposable income, attributable to persistent inflationary pressures and substantial wage moderation in both the public and private sectors, will be more difficult to offset through borrowing. Despite a reduction in the Bank of England’s key rate, credit will become both more expensive and less available with financial institutions, aware of the sharp increase in personal bankruptcies in 2007, exercising greater caution. A decline in housing prices would moreover hinder the mortgage equity withdrawals that currently represent 6 percent of disposable income. In this context, residential construction could well decline particularly for assets intended for rental purposes—where profitability has deteriorated substantially—as well as for the high end affected by the reduction of the bonuses distributed in the financial sector of the City. Office construction will slow due to the slowdown in services. Ongoing preparations for the 2012 Olympic Games along with the continuing dynamism of school, hospital and road and rail infrastructure construction will only partly offset that trend. Only the performance of goods exports, despite the flagging dynamism of the U.S. market (15 percent of sales) and the decline of the dollar, should improve, thanks to the weakening of the pound sterling against the euro. That will not suffice, however, to reduce a very large trade deficit only partly offset by the recurrent surplus position of the services and investment income balance.

In 2007, the Coface payment incident index remained satisfactory, bearing out the decline in bankruptcies. Corporate profitability remained high with profits increasing 10 percent. They could level off in 2008, albeit at a good level, amid a decline in economic activity. Although that will have little effect on large companies in view of their low-debt positions and good cash flow, smaller companies with limited access to the financial market and that rely on adjustable-rate loans in consequence will experience difficulties to varying degrees. The housing and home furnishings (manufacturing and retailing sector) should suffer from the decline in residential investment, even if that can be partly offset by orders from the public sector or related to preparations for the Olympics. Agricultural-product users and processors (breeders, cheese-makers, biscuit-makers, etc) will enjoy varying degrees of latitude to pass on the rising cost of those products in sales prices to their buyers. That may prove difficult when dealing with mass distribution where a context of sluggish consumption will exacerbate competition. Financial sector subcontracting will also present higher risk.

South Korea

The economy grew at a still respectable 4.8 percent rate in 2007, driven by goods exports and household consumption, itself spurred by an increase in disposable income and a wealth effect caused by rising property and stock market prices. Buoyant foreign demand benefited electronics, the automotive industry and shipbuilding in 2007. The country should prove relatively insensitive to the slowdown in 2008 in the United States, which represents only 15 percent of South Korean exports. In these conditions, the Coface payment experience has generally been good. Large innovative companies continue to post high profits albeit eroded by the won appreciation. Small companies focusing on the domestic market have been weaker.

Financially, sovereign risk has remained low. Despite the decline of the current account surplus in 2007 and the expected emergence of a deficit in 2008, foreign debt remains limited. Although South Korean banks are sound and profitable, the extent of household debt raises fears of new difficulties should interest rates increase sharply.

The political tensions with North Korea seem to be easing. The presidents of the two Koreas—Roh Moo Hyun and Kim Jong-Il—have committed themselves to opening negotiations. Prospects for a peace treaty are nonetheless still uncertain: With the December 2007 presidential elections allowing M. Lee Myung-Bak of the opposition Grand National Party to succeed Roh Moo Hyun, a tougher policy toward Pyongyang could emerge. In the domestic sphere, the new President, M. Lee Myung-Bak, and the future government resulting from the April 2008 legislative elections will be expected to undertake reforms as regards combating corruption and improving corporate transparency. Chaebol governance, characterized by family control and hereditary succession, remains a particularly large challenge.

France

Economic growth was slightly slower in 2007, underpinned mainly by household consumption (57 percent of GDP). Spending did not accelerate as expected, however, with households preferring to increase their savings substantially. The tax exemption granted for interest on property loans made it possible to postpone a soft landing for residential investment. Corporate productive investment remained at an acceptable level spurred by a lack of production capacity in many sectors. Foreign trade again made a slightly negative contribution to growth.

The growth trend should remain steady in 2008. Households should continue to spend at essentially the same rate registered last year with additional tax breaks partly offsetting rising prices for energy and food products. Stricter conditions for property loans will affect residential investment, which will continue to mark time and thereby contribute to the job creation slowdown. Public works, meanwhile, will remain buoyant, thanks to orders from local communities spurred by municipal elections. Higher loan rates and difficulties in arranging financing should prompt companies to postpone somewhat their investment project. The continuing decline of their profitability (down from 8.5 percent of GDP in 2000 to 5.2 percent in 2007) and cash flow ratios (from 85 percent in 2000 to 60 percent in 2008) has made them particularly sensitive to the cost of the credit on which they have increasingly relied since 2004. The weaker domestic demand will slow the growth of imports. Less buoyant demand from European trading partners and the euro appreciation in dollar zones will keep exports from achieving enough growth to improve the current account balance.

Bankruptcies have begun to increase again (up 9 percent in the first half last year). This trend reflects the erosion of corporate margins, particularly those of smaller companies, unable to pass price increases for energy and certain raw materials on in their sales prices. The effects of that phenomenon have been exacerbated by excessively slow productivity growth coupled with the overly steep rise of labor costs. Rising agricultural raw material prices could undermine certain intensive grain-user food sectors like meat and dairy products. The situation has, moreover, remained shaky in subcontracting to the car industry and aeronautics, paper/cardboard processing and textiles. The Coface payment incident index has nonetheless stabilized near the world average, and companies should generally remain profitable in 2008.

Taiwan

Growth slowed slightly in 2007 reflecting the slower growth in the United States, the Island’s main trading partner considering that about 70 percent of Taiwanese exports to Mainland China are subsequently re-exported to the United States. Foreign trade will cease being the main growth engine in 2008, with the domestic demand recovery making it possible to partially offset the reduced contribution of net exports. The electronics sector, responsible for 50 percent of Taiwanese exports, achieved good performance, thanks to the Island’s specialization in high value-added products with labor-intensive activities relocated to Mainland China. In this moderate-slowdown context, the payment experience recorded by Coface deteriorated with the margins of Taiwanese companies declining in 2007 for the third straight year.

The external financial situation remains robust with high foreign exchange reserves (the world’s fourth largest in value terms) and a substantial, though declining, current account surplus. The accumulation of fiscal deficits has, however, resulted in the build-up of substantial public sector debt, representing 50 percent of GDP. The institution of greater discipline—especially via tax reform that puts pressure on companies—has been stalled by the quasi-systematic opposition of parliament. The banking system, meanwhile, has to carry on with its restructuring program.

In the run-up to legislative and presidential elections, in January and March 2008 respectively, the decision process on economic matters has been impeded by growing tensions between the Kuomintang and the People First Party, which have the majority in parliament, and President Chen Shui-Bian’s Democratic Progressive Party. Weakened, moreover, by corruption scandals, President Chen has intensified his anti-Chinese rhetoric. This resurgence of tensions with Beijing could, nonetheless, ease if the opposition, believed to be more amenable to dialogue, comes out with the majority in the forthcoming elections. The holding of those legislative and presidential elections in the first three months of 2008 could loosen up the current wait-and-see situation.

Netherlands

The economy continued to expand strongly in 2007, driven by exports and domestic demand. Despite production slowdown affecting gas products early in the year, exports continued to grow buoyed by re-export activity, representing about 50 percent of the total and chemical industry performance. A dynamic job market spurred household spending. Companies continued to invest meanwhile albeit at a more moderate pace. With less-than-expected growth of royalties from natural gas exploration, however, the public sector ran another budget deficit.

Although the same economic engines will drive growth in 2008, most will be less buoyant. Moderating demand from the main European trading partners, particularly Germany and the United Kingdom, will limit export growth. The current account balance will nonetheless continue to show a large surplus. Increased taxes and social security contributions, high interest rates and an upsurge in inflation will undermine household spending. This negative impact will nonetheless be partially offset by the pressures buffeting the job market with unemployment declining to record lows and a labor shortage driving wages higher. Companies, meanwhile, will slow the pace of their investments in view of the more difficult conditions of access to credit and the deterrent effect of higher labor costs. The new tax and social measures included in the 2008 budget in conjunction with the growth of revenues from natural gas exploration will allow the government to run a slight surplus that will help fund spending on health, pensions and education and repayment of public debt.

Bankruptcies continued to decline in 2007, down 23.3 percent over the first nine months, a positive trend reflected by the Coface payment incident index, which has remained below the world average. The world demand slowdown could weaken the less robust companies in the very export-dependent manufacturing sector. The scarcity of skilled labor will moreover have a greater effect on labor-intensive companies and those relying labor with cutting-edge skills. Despite an increase in corporate tax, which nonetheless spared smaller companies, corporate financial health should remain good overall in 2008. wt



The Coface Group is a world leader in trade-risk management, serving over 100,000 clients in 93 countries worldwide. For more information, visit www.coface-usa.com.